Table of Contents

 

 

 

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**x****      QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**Forthe quarterly period ended January 31, 2010**

 

**or**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thetransition period from [    ] to [    ]**

 

**CommissionFile No. 1-8125**

 

**TOROTEL, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **MISSOURI**                                                    | ** ** | **44-0610086**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

| **620  NORTH LINDENWOOD DRIVE, OLATHE, KANSAS** | ** ** | **66062**  |
|-------------------------------------------------|------------|------------|
| (Address of  principal executive offices)       |       | (Zip Code) |

 

**(913)747-6111**

(Registrant’stelephone number, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yesx  No o

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).   Yes o   No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large  accelerated filer o                                              |   | Accelerated  filer o         |
|-------------------------------------------------------------------------|--------|------------------------------|
| Non-accelerated  filer o  (Do not check if a smaller reporting company) |   | Smaller  reporting company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934).    Yes o   No x

 

As of March 12,2010, there were 5,873,100 shares of Common Stock, $.01 par value, outstanding.

 

 

 

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TOROTEL, INC. ANDSUBSIDIARIES

 

INDEX

 
| PART I.  | FINANCIAL INFORMATION                                                                            |   |   |
|---------------|--------------------------------------------------------------------------------------------------|--------|--------|
|          |                                                                                             |   |   |
| Item 1.       | Financial Statements                                                                             |   |   |
|          |                                                                                             |   |   |
|          | Consolidated Condensed  Balance Sheets as of January 31, 2010 and April 30, 2009       |   | 1      |
|          |                                                                                             |   |   |
|          | Consolidated Statements of  Operations for the nine months ended January 31, 2010 and 2009  |   | 2      |
|          |                                                                                             |   |   |
|          | Consolidated Statements of  Operations for the three months ended January 31, 2010 and 2009 |   | 3      |
|          |                                                                                             |   |   |
|          | Consolidated Statements of  Cash Flows for the nine months ended January 31, 2010 and 2009  |   | 4      |
|          |                                                                                             |   |   |
|          | Notes to  Consolidated Condensed Financial Statements                                            |   | 5      |
|          |                                                                                             |   |   |
| Item 2.       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations      |   | 12     |
|          |                                                                                             |   |   |
| Item 4T.      | Controls and  Procedures                                                                         |   | 20     |
|          |                                                                                             |   |   |
| PART II. | OTHER INFORMATION                                                                                |   |   |
|          |                                                                                             |   |   |
| Item 6.       | Exhibits                                                                                         |   | 21     |
|          |                                                                                             |   |   |
| SIGNATURES    |                                                                                             | 22     |
|               |                                                                                                  |        |        |  |  |

 

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**PART I.     FINANCIAL INFORMATION**

 

**Item1.       Financial Statements**

 

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

 
| ** **                                 | ** ** | **(Unaudited)**      | ** ** | ** **         | ** ** |
|--------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **As of**       | ** ** | **As of**     | ** ** |
| ** **                                 | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
| ** **                                 | ** ** | **2010**             | ** ** | **2009**           | ** ** |
| ASSETS                                     |       |                 |       |               |       |
|                                       |       |                 |       |               |       |
| Current  assets:                           |       |                 |       |               |       |
| Cash                                       |       | $                    | 599,000    |               | $          | 656,000 |   |
| Trade  receivables, net                    |       | 604,000              |       | 559,000            |       |
| Inventories,  net                          |       | 1,119,000            |       | 822,000            |       |
| Prepaid  expenses and other current assets |       | 39,000               |       | 19,000             |       |
|                                       |       | 2,361,000            |       | 2,056,000          |       |
|                                       |       |                 |       |               |       |
| Property,  plant and equipment, net        |       | 965,000              |       | 970,000            |       |
|                                       |       |                 |       |               |       |
|                                       |       | $                    | 3,326,000  |               | $          | 3,026,000 |   |
|                                       |       |                 |       |               |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY |       |                 |       |               |       |
|                                       |       |                 |       |               |       |
| Current  liabilities:                      |       |                 |       |               |       |
| Current  maturities of long-term debt      |       | $                    | 94,000     |               | $          | 78,000 |   |
| Trade  accounts payable                    |       | 358,000              |       | 180,000            |       |
| Accrued  liabilities                       |       | 161,000              |       | 211,000            |       |
| Customer  deposits                         |       | 409,000              |       | —             |       |
|                                       |       | 1,022,000            |       | 469,000            |       |
|                                       |       |                 |       |               |       |
| Long-term  debt, less current maturities   |       | 528,000              |       | 588,000            |       |
|                                       |       |                 |       |               |       |
| Stockholders’  equity                 |       | 1,776,000            |       | 1,969,000          |       |
|                                       |       |                 |       |               |       |
|                                       |       | $                    | 3,326,000  |               | $          | 3,026,000 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                         | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **January 31,**  | ** ** | **January 31,** | ** ** |
| ** **                                         | ** ** | **2010**              | ** ** | **2009** | ** ** |
| Net  sales                                         |       | $                     | 4,844,000  |   | $ | 5,579,000 |   |
| Cost  of goods sold                                |       | 3,203,000             |       | 3,556,000 |   |
|                                               |       |                  |       |   |   |
| Gross  profit                                      |       | 1,641,000             |       | 2,023,000 |   |
|                                               |       |                  |       |   |   |
| Operating  expenses:                               |       |                  |       |   |   |
| Engineering                                        |       | 241,000               |       | 264,000 |   |
| Selling,  general and administrative               |       | 1,617,000             |       | 1,365,000 |   |
|                                               |       | 1,858,000             |       | 1,629,000 |   |
| Earnings  (loss) from operations                   |       | (217,000              | )          | 394,000 |   |
|                                               |       |                  |       |   |   |
| Other  expense:                                    |       |                  |       |   |   |
| Interest  expense                                  |       | 33,000                |       | 43,000 |   |
|                                               |       |                  |       |   |   |
| Earnings  (loss) before provision for income taxes |       | (250,000              | )          | 351,000 |   |
|                                               |       |                  |       |   |   |
| Provision  for income taxes                        |       | —                |       | — |   |
|                                               |       |                  |       |   |   |
| Net  earnings (loss)                               |       | $                     | (250,000   | ) | $ | 351,000 |   |
|                                               |       |                  |       |   |   |
| Basic  earnings (loss) per share                   |       | $                     | (.05       | ) | $ | .07 |   |
|                                               |       |                  |       |   |   |
| Diluted  earnings (loss) per share                 |       | $                     | (.05       | ) | $ | .06 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **January 31,**             | ** ** | **January 31,** | ** ** |
| ** **                                         | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Net  sales                                         |       | $                                | 1,550,000  |   | $ | 1,619,000 |   |
| Cost  of goods sold                                |       | 1,069,000                        |       | 1,044,000 |   |
|                                               |       |                             |       |   |   |
| Gross  profit                                      |       | 481,000                          |       | 575,000 |   |
|                                               |       |                             |       |   |   |
| Operating  expenses:                               |       |                             |       |   |   |
| Engineering                                        |       | 71,000                           |       | 87,000 |   |
| Selling,  general and administrative               |       | 526,000                          |       | 372,000 |   |
|                                               |       | 597,000                          |       | 459,000 |   |
| Earnings  (loss) from operations                   |       | (116,000                         | )          | 116,000 |   |
|                                               |       |                             |       |   |   |
| Other  expense:                                    |       |                             |       |   |   |
| Interest  expense                                  |       | 10,000                           |       | 14,000 |   |
|                                               |       |                             |       |   |   |
| Earnings  (loss) before provision for income taxes |       | (126,000                         | )          | 102,000 |   |
|                                               |       |                             |       |   |   |
| Provision  for income taxes                        |       | —                           |       | — |   |
|                                               |       |                             |       |   |   |
| Net  earnings (loss)                               |       | $                                | (126,000   | ) | $ | 102,000 |   |
|                                               |       |                             |       |   |   |
| Basic  earnings (loss) per share                   |       | $                                | (.02       | ) | $ | .02 |   |
|                                               |       |                             |       |   |   |
| Diluted  earnings (loss) per share                 |       | $                                | (.02       | ) | $ | .02 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

 
| ** **                                                                                             | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                             | ** ** | **January 31,**            | ** ** | **January 31,** | ** ** |
| ** **                                                                                             | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| Cash  flows from operating activities:                                                                 |       |                            |       |   |   |
| Net  earnings (loss)                                                                                   |       | $                               | (250,000   | ) | $ | 351,000 |   |
| Adjustments  to reconcile net earnings (loss) to net cash provided by (used in) operating  activities: |       |                            |       |   |   |
| Loss  on disposal of assets                                                                            |       | —                          |       | 1,000 |   |
| Cost  of restricted stock forfeited                                                                    |       | 12,000                          |       | — |   |
| Stock  compensation earned                                                                             |       | 45,000                          |       | 49,000 |   |
| Depreciation                                                                                           |       | 79,000                          |       | 78,000 |   |
| Change  in value of stock appreciation rights                                                          |       | 8,000                           |       | (24,000 | ) |
| Increase  (decrease) in cash flows from operations resulting from changes in:                          |       |                            |       |   |   |
| Trade  receivables                                                                                     |       | (45,000                         | )          | (44,000 | ) |
| Inventories                                                                                            |       | (297,000                        | )          | (273,000 | ) |
| Prepaid  expenses and other assets                                                                     |       | (20,000                         | )          | (15,000 | ) |
| Trade  accounts payable                                                                                |       | 178,000                         |       | (121,000 | ) |
| Accrued  liabilities                                                                                   |       | (58,000                         | )          | (20,000 | ) |
| Customer  deposits                                                                                     |       | 409,000                         |       | — |   |
|                                                                                                   |       |                            |       |   |   |
| Net  cash provided by (used in) operating activities                                                   |       | 60,000                          |       | (18,000 | ) |
|                                                                                                   |       |                            |       |   |   |
| Cash  flows from investing activities:                                                                 |       |                            |       |   |   |
| Capital  expenditures                                                                                  |       | (74,000                         | )          | (21,000 | ) |
|                                                                                                   |       |                            |       |   |   |
| Net  cash used in investing activities                                                                 |       | (74,000                         | )          | (21,000 | ) |
|                                                                                                   |       |                            |       |   |   |
| Cash  flows from financing activities:                                                                 |       |                            |       |   |   |
| Proceeds  from long-term debt                                                                          |       | 22,000                          |       | — |   |
| Principal  payments on long-term debt                                                                  |       | (58,000                         | )          | (47,000 | ) |
| Payments  on capital lease obligations                                                                 |       | (8,000                          | )          | (6,000 | ) |
|                                                                                                   |       |                            |       |   |   |
| Net  cash used in financing activities                                                                 |       | (43,000                         | )          | (53,000 | ) |
|                                                                                                   |       |                            |       |   |   |
| Net  decrease in cash                                                                                  |       | (57,000                         | )          | (92,000 | ) |
| Cash,  beginning of period                                                                             |       | 656,000                         |       | 410,000 |   |
|                                                                                                   |       |                            |       |   |   |
| Cash,  end of period                                                                                   |       | $                               | 599,000    |   | $ | 318,000 |   |
|                                                                                                   |       |                            |       |   |   |
| Supplemental  Disclosures of Cash Flow Information                                                     |       |                            |       |   |   |
| Cash  paid during the period for:                                                                      |       |                            |       |   |   |
| Interest                                                                                               |       | $                               | 33,000     |   | $ | 43,000 |   |
| Income  taxes                                                                                          |       | $                               | —     |   | $ | — |   |
|                                                                                                   |       |                            |       |   |   |
| Non-cash  investing and financing activities:                                                          |       |                            |       |   |   |
| Capital  expenditure                                                                                   |       | $                               | —     |   | $ | (27,000 | ) |
| Proceeds  from capital lease                                                                           |       | $                               | —     |   | $ | 27,000 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**NOTES TOCONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)**

 

**Note 1 —Basis of Presentation**

 

The consolidatedcondensed balance sheet as of April 30, 2009, which has been derived fromaudited financial statements, is accompanied by the unaudited interimconsolidated condensed financial statements, which reflect the normal recurringadjustments that in the opinion of management are necessary to present fairly Torotel’sfinancial position at January 31, 2010, and the results of operations forthe three and nine months ended January 31, 2010.

 

The unaudited interimconsolidated condensed financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and note disclosuresnormally included in the annual financial statements prepared in accordancewith generally accepted accounting principles have been condensed or omittedpursuant to those rules and regulations, although management believes thedisclosures made are adequate to make the information not misleading.

 

The financial statementscontained herein should be read in conjunction with Torotel’s financialstatements and related notes filed on Form 10-K for the year ended April 30,2009.

 

**Note 2 —Nature of Operations**

 

Torotel, Inc. (“Torotel”)conducts business through three wholly owned subsidiaries, Torotel Products, Inc.(“Torotel Products”), Torotel Manufacturing, and Electronika, Inc. (“Electronika”).  Torotel specializes in the custom design andmanufacture of a wide variety of precision magnetic components, consisting oftransformers, inductors, reactors, chokes and toroidal coils, for use incommercial, industrial and military electronics.  Torotel also designs and distributes ballasttransformers for the airline industry. Approximately 96% of Torotel’s sales during the first nine months offiscal 2010 have been derived from domestic customers.  Torotel Manufacturing provides manufacturingservices to Torotel Products.

 

**Note 3****— Inventories**

 

The components ofinventories are summarized as follows:

 
| ** **       | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|------------------|------------|----------------------|------------|--------------------|------------|
| ** **       | ** ** | **2010**             | ** ** | **2009**           | ** ** |
| Raw  materials   |       | $                    | 613,000    |               | $          | 567,000 |   |
| Work  in process |       | 385,000              |       | 141,000            |       |
| Finished  goods  |       | 121,000              |       | 114,000            |       |
|             |       | $                    | 1,119,000  |               | $          | 822,000 |   |

 

 

**Note 4 —Income Taxes**

 

As of January 31,2010, the federal tax returns for the fiscal years ended 2005 through 2009 willremain open to audit until the statute of limitations closes for the years inwhich the net operating losses are utilized. Torotel would recognize interest and penalties accrued on unrecognizedtax benefits as well as interest received from favorable tax settlements withinincome tax expense.  As of January 31,2010, Torotel recorded no accrued interest or penalties related to uncertaintax positions.  Management expects nosignificant change in the amount of unrecognized tax benefit, accrued interestor penalties within the next twelve months.

 

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**Note 5 —Financing Agreements**

 

OnJune 1, 2009, Torotel Products refinanced its mortgage debt with the Bankof Blue Valley.  Under the terms of therefinancing, the outstanding balance bears interest at a fixed rate of 6.5% perannum and requires monthly principal and interest payments of $9,543.  The note, which is guaranteed by Torotel, Inc.and Electronika, Inc., has a maturity date of May 25, 2014, may be prepaidwithout penalty and is collateralized by substantially all assets of Torotel.

 

On September 30,2009, Torotel Products renewed its $500,000 revolving credit agreement withBank of Blue Valley.  Advances under thecredit line are limited to 75% of eligible billed receivables.  The revolving line is collateralized by theland and buildings in Olathe, Kansas. Under the terms of the agreement, the outstanding balance of the revolvingline bears interest at 1.00% over the bank’s corporate base rate with aninterest rate floor of 6.00% and has a maturity date of September 30,2010.  As of January 31, 2010, theeffective borrowing rate was 6.00% and the entire credit line was available.

 

**Note6 — Restricted Stock Agreements**

 

RestrictedStock Agreements are authorized by the Compensation and Nominating Committee (“Committee”)and the Board of Directors of Torotel. The Committee and the Board have determined that the interests ofTorotel and its stockholders will be promoted by hiring talented individualsand, to induce such individuals to accept employment with Torotel, theCommittee and the Board believe a key component of such individuals’compensation should be granting equity ownership opportunities based upon theacceptance of employment and the continuing employment of such individual,subject to certain conditions and restrictions. The Restricted Stock Agreements afford the grantees all of the rights ofa stockholder with respect to the award shares, including the right to votesuch shares and to receive dividends and other distributions payable withrespect to such shares since the Date of Award. Under the terms of each agreement, the non-vested shares are restrictedas to disposition and subject to forfeiture under certain circumstances.  The agreements further provide, subject tocertain conditions, that if prior to all of the restricted shares having beenreleased, Torotel undergoes a change in control, then all of the restrictedshares shall be released and no longer subject to restrictions under theagreements.  Upon issuance of therestricted stock, the aggregate number of shares issued is credited to commonstock at $.01 par value per share and the excess of the market price of thecommon stock on the date of issuance over the par value is credited to capitalin excess of par value.  The restrictedshares are treated as non-vested stock; accordingly, the fair value of therestricted stock at the date of award is offset against capital in excess ofpar value in the accompanying consolidated balance sheets under stockholders’equity.

 

Torotel has RestrictedStock Agreements dated August 7, 2007, with eight (8) key employeespursuant to the Stock Award Plan (“SAP”). The SAP provides key employees the opportunity to acquire common stockof Torotel pursuant to awards earned for accomplishing goals that promote thelong-term financial performance of Torotel. Under the terms of the SAP, which was filed as Exhibit 10.9 of Form 10-KSBfor the fiscal year ended April 30, 2007, the restricted stock awards havea five (5) year restriction period, which shall lapse based on certainconditions as outlined in the SAP.  As ofJanuary 31, 2010, the aggregate amount of the existing restricted stockawards was 357,350 shares.  Stockcompensation cost of $9,000 for the existing restricted stock awards will berecorded per quarter during the remaining five-year vesting period provided thefinancial performance metrics as outlined in the SAP are likely to be attained.

 

On September 2,2009, Torotel entered into Restricted Stock Agreements with two (2) keyemployees (Messrs. Sizemore and Serrone) pursuant to the SAP.  The aggregate amount of the restricted stockawards 

 

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was 250,000 shares ofcommon stock, $.01 par value per share. Based on the market price of $.27 for Torotel’s common stock as of September 2,2009, the fair value of the restricted stock at the date of award was $67,500.  Stock compensation cost of $3,000 will berecorded per quarter during the five-year vesting period provided the financialperformance metrics as outlined in the SAP are likely to be attained.

 

Total stock compensationcost for the three months ended January 31, 2010 and 2009 was $22,000 and$16,000, respectively.  Total stockcompensation cost for the nine months ended January 31, 2010 and 2009 was$57,000 and $32,000, respectively.

 

Restricted stock activityfor each nine month period through January 31 is summarized as follows:

 
| ** **                      | ** ** | **2010**       | ** ** | **2009**     | ** ** |
|---------------------------------|------------|----------------|------------|--------------|------------|
| ** **                      | ** ** | **Restricted** | ** ** | **Weighted** | ** ** | **Restricted** | ** ** | **Weighted** | ** ** |
| ** **                      | ** ** | **Shares**     | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** | ** ** |
| ** **                      | ** ** | **Under**      | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                      | ** ** | **Option**     | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  May 1      |       | 434,910        |       | $            | .500       |   | 686,750 |   | $ | .453 |   |
| Granted                         |       | 250,000        |       | $            | .270       |   | — |   | — |   |
| Vested                          |       | (34,160        | )          | $            | .500       |   | (40,000 | ) | $ | .300 |   |
| Forfeited                       |       | (43,400        | )          | $            | .500       |   | — |   | — |   |
| Outstanding  at January 31 |       | 607,350        |       | $            | .405       |   | 646,750 |   | $ | .463 |   |

 

**Note 7 —Stockholders’ Equity**

 

The components ofstockholders’ equity are summarized as follows:

 
| ** **                      | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|---------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                      | ** ** | **2010**             | ** ** | **2009**           | ** ** |
| Common  stock, at par value     |       | $                    | 60,000     |               | $          | 60,000 |   |
| Capital  in excess of par value |       | 12,529,000           |       | 12,472,000         |       |
| Accumulated  deficit            |       | (10,723,000          | )          | (10,473,000        | )          |
|                            |       | 1,866,000            |       | 2,059,000          |       |
| Less  treasury stock, at cost   |       | 90,000               |       | 90,000             |       |
|                            |       | $                    | 1,776,000  |               | $          | 1,969,000 |   |

 

Torotelhas 6,000,000 shares of common stock, $.01 par value, authorized and 5,873,100shares issued and outstanding.  Thechanges in shares of common stock outstanding as of January 31 of each periodare summarized as follows:

 
| ** **                 | ** ** | **2010**  | ** ** | **2009**  | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|
| Balance,  May 1       |       | 5,666,500 |       | 5,878,340 |       |
| Restricted  stock activity |       | 250,000   |       | —    |       |
| Treasury  stock activity   |       | (43,400   | )          | —    |       |
|                       |       |      |       |      |       |
| Balance,  January 31  |       | 5,873,100 |       | 5,878,340 |       |

 

**Note8 — Earnings Per Share**

 

Torotel utilizes adual presentation of basic and diluted earnings per share (“EPS”) on the faceof the consolidated statements of operations and provides a reconciliation ofthe numerator and denominator used in computing basic and diluted EPS.  Basic EPS excludes dilution and is computedby dividing earnings available to common stockholders by the weighted averagenumber of common shares outstanding for the period.  Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock wereexercised or converted into common stock or resulted in the issuance of commonstock 

 

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that then sharedin the earnings of the entity.  The607,350 shares issued pursuant to the Restricted Stock Agreements (see Note 6of Notes to Consolidated Condensed Financial Statements) meet the definition ofcontingently issuable shares; as a result, these shares will not be included inthe basic EPS calculation until the performance measurements have beensatisfied.  The restricted shares will betreated as a common stock equivalent for the diluted EPS calculation.

 

The basic anddiluted earnings per common share were computed as follows:

 

# **Year-to-Date EPS Calculations**

# ** **

| ** **                                                   | ** ** | **2010**  | ** ** | **2009**  | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net  earnings (loss)                                         |       | $         | (250,000   | )         | $          | 351,000 |   |
|                                                         |       |      |       |      |       |
| Weighted  average common shares outstanding for basic EPS    |       | 5,235,551 |       | 5,218,402 |       |
| Incremental  shares for effect of restricted stock           |       | —    |       | 659,938   |       |
| Weighted  average common shares outstanding for dilutive EPS |       | 5,235,551 |       | 5,878,340 |       |
|                                                         |       |      |       |      |       |
| Basic  earnings (loss) per share                             |       | $         | (.05       | )         | $          | .07 |   |
| Diluted  earnings (loss) per share                           |       | $         | (.05       | )         | $          | .06 |   |

 

No incrementalshares are included in the 2010 EPS calculations for the 607,350 shares ofrestricted common stock since the effect would be anti-dilutive.

 

# **Quarterly EPS Calculations**

# ** **

| ** **                                                   | ** ** | **2010**  | ** ** | **2009**  | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net  earnings (loss)                                         |       | $         | (126,000   | )         | $          | 102,000 |   |
|                                                         |       |      |       |      |       |
| Weighted  average common shares outstanding for basic EPS    |       | 5,243,472 |       | 5,231,590 |       |
| Incremental  shares for effect of restricted stock           |       | —    |       | 646,750   |       |
| Weighted  average common shares outstanding for dilutive EPS |       | 5,243,472 |       | 5,878,340 |       |
|                                                         |       |      |       |      |       |
| Basic  earnings (loss) per share                             |       | $         | (.02       | )         | $          | .02 |   |
| Diluted  earnings (loss) per share                           |       | $         | (.02       | )         | $          | .02 |   |

 

No incrementalshares are included in the 2010 EPS calculations for the 607,350 shares ofrestricted common stock since the effect would be anti-dilutive.

 

**Note9 — Stock Appreciation Rights**

 

The board of directors of Torotel approved the Directors StockAppreciation Rights Plan (the “Plan”) for non-employee directors in September 2004.  Each stock appreciation right (“SAR”) isequal to one share of common stock of Torotel, and the aggregate number of SARsthat may be granted under the Plan shall not exceed 500,000.  The effective date of the Plan is October 1,2004, and the Plan has a term of ten (10) years.

 

Pursuant to the Plan,20,000 SARs were granted on the effective date to each of the three currentnon-employee directors serving at that time. The initial price at which each SAR was granted was $.35, which equaledthe market price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant.

 

SARs shall automaticallybe granted in the future as follows: (1) each person who is elected as a director,who was not a director on the effective date of the Plan, shall be granted10,000 SARs on the date such person is elected a director; and (2) on eachMay 1 following the effective date during the term of the Plan, eachperson serving as a director on such date shall be granted 10,000 SARs.  After the initial grant the price at whicheach SAR is granted shall be the average of the closing price of Torotel’scommon stock for the ten consecutive days immediately preceding the date ofgrant.  Upon exercise of a SAR, Torotelwill

 

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pay the grantee an amount (the “Spread”) equal to theexcess of the Exercise Price over the SAR grant price multiplied by the numberof shares being exercised.  The ExercisePrice shall be the average of the closing price of Torotel’s common stock for theten consecutive days immediately preceding the notice of exercise.  For any payments that exceed $10,000, Torotelhas the option to make quarterly payments over three years with interestpayable quarterly at the prime rate of Torotel’s primary bank.

 

EachSAR granted hereunder may be exercised to the extent that the grantee is vestedin such SAR.  The SARs will vestaccording to the following schedule:

 
| **Number of Years the Grantee has remained** | ** ** | **Shares represented** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------|------------|
| **a Torotel director of the Company following**                            | ** ** | **by a SAR in which**       | ** ** |
| **the Date of Grant**                                                      | ** ** | **a Grantee is Vested**     | ** ** |
| Under  one                                                                 |       | 0                           | %          |
| At  least one but less than two                                            |       | 33                          | %          |
| At  least two but less than three                                          |       | 67                          | %          |
| Three  or more                                                             |       | 100                         | %          |

 

A grantee shallbecome fully (100%) vested in each of their SARs under the followingcircumstances: (i) upon termination of the grantee’s service as a directorof Torotel for reasons of death, disability or retirement; (ii) if theCompensation and Nominating Committee (the “Committee”), in its solediscretion, determines that acceleration of the SAR vesting schedule would bedesirable for Torotel; or (iii) if Torotel shall, pursuant to action byits Board of Directors, at any time propose to merge into, consolidate with, orsell or otherwise transfer all or substantially all of its assets to anothercorporation, and provision is not made pursuant to the terms of suchtransaction for the assumption by the surviving, resulting or acquiringcorporation of outstanding SARs or for substitution of new SARs therefore, theCommittee shall cause written notice of the proposed transaction to be given toeach grantee not less than twenty days prior to the anticipated effective dateof the proposed transaction, and his or her SARs shall become fully (100%)vested and, prior to a date specified in such notice, which shall be not morethan ten days prior to the anticipated effective date of the proposedtransaction, each grantee shall have the right to exercise his or her SARs.

 

Compensation expense is recognized over the vesting period based uponthe estimated fair value of the SARs pursuant to the terms of the Plan usingthe Black-Scholes options-pricing model as of the end of each financialreporting period.  As of January 31,2009, the fair value of the SARs was determined using the followingassumptions: no dividend payments over the life of the SARs since Torotel hasnot issued any form of dividend since 1985; an expected volatility of 137.4%based on Torotel’s historical volatility using the weekly closing price overthe past three years; a risk-free interest rate of 1.75%; and an expected lifeof three years based on the length of service estimated to be served.  As of January 31, 2010, the fair valueof the SARs was determined using the following assumptions: no dividendpayments over the life of the SARs since Torotel has not issued any form ofdividend since 1985; an expected volatility of 107.5% based on Torotel’shistorical volatility using the weekly closing price over the past three years;a risk-free interest rate of 2.50%; and an expected life of three years basedon the length of service estimated to be served.  Based on these assumptions, the fair valueprices per share of the outstanding SARs as of January 31, 2010, aresummarized as follows:

 
| ** **            | ** ** | **SARs**   | ** ** | ** **   | ** ** | ** **          | ** ** | ** ** | ** ** | **Aggregate**       | ** ** | **Aggregate** | ** ** |
|-----------------------|------------|------------|------------|--------------|------------|---------------------|------------|------------|------------|---------------------|------------|---------------|------------|
| ** **            | ** ** | **Under**  | ** ** | **Exercise** | ** ** | **Fair Value** | ** ** | **%**      | ** ** | **Vested**          | ** ** | **Intrinsic** | ** ** |
| **Grant Date**   | ** ** | **Option** | ** ** | **Price**    | ** ** | **Price**           | ** ** | **Vested** | ** ** | **Fair Value** | ** ** | **Value**     | ** ** |
| October 1,  2004 |       | 60,000     |       | $            | .350       |                | $          | .166       |       | 100                 | %          | $             | 10,000     |   | $ | — |   |
| May 1,  2005     |       | 30,000     |       | $            | .302       |                | $          | .173       |       | 100                 | %          | $             | 5,000      |   | $ | — |   |
| May 1,  2006     |       | 30,000     |       | $            | .695       |                | $          | .131       |       | 100                 | %          | $             | 4,000      |   | $ | — |   |
| May 1,  2007     |       | 30,000     |       | $            | .500       |                | $          | .148       |       | 67                  | %          | $             | 3,000      |   | $ | — |   |
| June 4,  2007    |       | 10,000     |       | $            | .412       |                | $          | .158       |       | 67                  | %          | $             | 1,000      |   | $ | — |   |
| May 1,  2008     |       | 40,000     |       | $            | .550       |                | $          | .143       |       | 33                  | %          | $             | 2,000      |   | $ | — |   |
| May 1,  2009     |       | 40,000     |       | $            | .208       |                | $          | .190       |       | 0                   | %          | $             | —     |   | $ | 2,000 |   |

 

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The vested portionrepresents 160,000 SARs.  As of January 31,2010, the total aggregate intrinsic value of these exercisable SARs was $2,000.

 

SARs transactions for each nine month period through January 31are summarized as follows:

 
| ** **                                                     | ** ** | **2010**   | ** ** | **2009**     | ** ** |
|----------------------------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                     | ** ** | **SARs**   | ** ** | **Average**  | ** ** | **SARs** | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**  | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                                                     | ** ** | **Option** | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding  at May 1                                     |       | 200,000    |       | $            | .460       |   | 160,000 |   | $ | .438 |   |
| Granted                                                        |       | 40,000     |       | $            | .208       |   | 40,000 |   | $ | .550 |   |
| Exercised                                                      |       | —     |       | —       |       | — |   | — |   |
| Forfeited                                                      |       | —     |       | —       |       | — |   | — |   |
| Outstanding  at January 31                                |       | 240,000    |       | $            | .418       |   | 200,000 |   | $ | .460 |   |
|                                                           |       |       |       |         |       |   |   |   |   |
| SARs  exercisable at end of period                             |       | 160,000    |       | $            | .444       |   | 123,300 |   | $ | .408 |   |
| Weighted  average fair value of SARs granted during the period |       |       |       | $            | .190       |   |   |   | $ | .168 |   |

 

The following informationapplies to SARs outstanding for each nine month period through January 31:

 
| ** **                                   | ** ** | **2010**  | ** **    | **2009**  | ** ** |
|----------------------------------------------|------------|-----------|---------------|-----------|------------|
| Number  outstanding                          |       | 240,000   |          | 200,000   |       |
| Range  of grant prices                       |       |      | $.208 - $.695 |      |       | $.302 - $.695 |   |
| Weighted  average grant price                |       |      | $.418         |      |       | $.460 |   |
| Weighted  average remaining contractual life |       | 6.73 yrs. |          | 7.23 yrs. |       |

 

Total compensationexpense for the outstanding SARs for the nine months ended January 31,2010 and 2009 was an expense of $8,000 and a credit of $24,000,respectively.  Total compensation expensefor the outstanding SARs for the three months ended January 31, 2010 and2009 was an expense of $4,000 and a credit of $22,000, respectively.  As of January 31, 2010, there was$13,000 of total unrecognized compensation expense related to non-vested SARsgranted under the Plan.  That cost isexpected to be recognized over a weighted average period of .63 years.  The liability for SARs on the consolidatedcondensed balance sheets as of January 31, 2010 and April 30, 2009,was $25,000 and $17,000, respectively.

 

**Note 10 —****Customer Deposits**

 

The new contract for the potted coil assembly providesfor milestone payments in the aggregate amount of $1,148,000 to be paid by thecustomer prior to the commencement of product deliveries in April 2010.  This aggregate amount will be used to procureraw materials and to establish a 500-piece finished goods buffer as requestedby the customer.  As of January 31,2010, Torotel had received milestone payments of $409,000.  This amount is reflected as a customerdeposit under current liabilities in the accompanying consolidated condensedbalance sheet.  These milestone paymentswill be applied to invoices ratably over the course of the contract as productis delivered.  In accordance with itsrevenue recognition policy, Torotel will recognize revenue on this contractupon monthly delivery of the product.

 

**Note 11 —****Concentrations ofCredit Risk**

 

Financial instruments that potentially subject Torotelto concentrations of credit risk consist principally of cash and accountsreceivable.  Torotel grants unsecuredcredit to most of its customers. Management does

 

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not believe that it is exposed to any extraordinarycredit risk as a result of this policy. At various times, and at January 31, 2010, cash balances exceededfederally insured limits.  Torotel hasnot experienced any losses in the cash accounts and management does not believeTorotel is exposed to any significant credit risk with respect to its cash.

 

**Note 12 —****New AccountingPronouncement**

 

Torotel adopted *The FASB Accounting Standards Codification andthe Hierarchy of Generally Accepted Accounting Principles*effective August 1,2009.  The FASB Accounting StandardsCodification (“Codification”) is identified as the source of authoritative U.S.GAAP recognized by the FASB to be applied by non-governmental entities.  Rules and interpretive releases of theSEC under authority of federal securities laws are also sources ofauthoritative GAAP for SEC registrants. On the effective date, the Codification superseded all then-existingnon-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not includedin the Codification is non-authoritative.

 

In the third quarter offiscal 2010, Torotel adopted FASB Accounting Standards Update (ASU) No. 2010-09,Amendments to Certain Recognition and Disclosure Requirements, which amends ASC855, Subsequent Events.  This ASU removesthe requirement for a SEC filer to disclose a date through which subsequentevents have been evaluated.  This changeremoves potential conflicts with SEC requirements.  The adoption did not have a material effecton Torotel’s consolidated financial statements.

 

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**Item 2.       Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*Overview*

 

Torotel, Inc. (“Torotel”) conducts businessprimarily through three wholly owned subsidiaries, Torotel Products, Inc.(“Torotel Products”), Torotel Manufacturing, Inc., and Electronika, Inc.(“Electronika”).  Torotel Manufacturing, Inc.provides manufacturing services to Torotel.

 

Torotel Products designs and manufactures a widevariety of magnetic components for use in military, aerospace and industrialelectronic applications.  These magneticcomponents, which consist of transformers, inductors, reactors, chokes, andtoroidal coils, are used to modify and control electrical voltages and currentsin electronic devices.  For example, ifequipment containing one of these components receives an electrical voltage orcurrent which is too high for proper operation of the equipment, the componentwould modify and control the electrical voltage or current to allow properoperation of the equipment.  WhileTorotel Products primarily manufactures the components in accordance withpre-developed mechanical and electrical requirements, in some cases it will beresponsible for both the overall design and manufacture of the components.  The magnetic components are sold tomanufacturers who incorporate them into an end-product.  The major applications include aircraft navigationalequipment, voice and data secure communications, medical equipment, avionicsequipment, down-hole drilling and conventional missile guidance systems.  As part of its growth strategy, TorotelProducts has been actively pursuing opportunities in electro-mechanicalassemblies.  These efforts resulted innearly $800,000 of new business from two new customers in fiscal 2009 and anadditional $590,000 in fiscal 2010. Assemblies will continue to be a major market focus going forward.

 

Torotel Products markets its components primarilythrough an internal sales force and through independent manufacturers’representatives paid on a commission basis. These commissions are earned when a product is sold and/or shipped to acustomer within the representative’s assigned territory.  Torotel Products also utilizes itsengineering department in its direct sales efforts for the purpose of expandingits reach into new markets and/or customers.

 

Torotel Products is an approved source for magneticcomponents used in numerous military and aerospace systems, which means TorotelProducts is automatically solicited for any procurement needs for suchapplications.  The magnetic componentsmanufactured by Torotel Products are sold primarily in the United States, andmost sales are awarded on a competitive bid basis.  The markets in which Torotel Productscompetes are highly competitive.  Asubstantial number of companies sell components of the type manufactured andsold by Torotel Products.  In addition,Torotel Products sells to a number of customers who have the capability ofmanufacturing their own electronic components. The principal methods of competition for electronic products in themarkets served by Torotel Products include, among other factors, price, on-timedelivery performance, lead times, customized product engineering and technicalsupport, marketing capabilities, quality assurance, manufacturing efficiency,and existing relationships with customers’ engineers.  While magnetic components are not susceptibleto rapid technological change, Torotel Products’ sales, which do not representa significant share of the industry’s market, are susceptible to decline giventhe competitive nature of the market.

 

Electronika is a marketing and licensing companyselling ballast transformers to the airline industry.  These transformers activate and control thelights in commercial airplane cockpits. Electronika’s ballast transformers are approved as spare and replacementparts in DC-8, DC-9, DC-10, MD-80 and MD-88 aircraft; however, sales of ballasttransformers have been made primarily for use in DC-8 and DC-9 aircraft.  As a result, the business of Electronika issubject to various risks including, without limitation, any decline in use ofthe referenced aircraft, and competition for the available spare partsbusiness.  Electronika’s sales do notrepresent a significant portion of any particular market.

 

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Electronika’s requirements for the ballasttransformers are outsourced pursuant to a Manufacturing Agreement withMagnetika, a corporation owned by the Caloyeras family.  Under the terms of the agreement, Magnetikaprovides all necessary raw material, labor, testing, packaging and relatedservices required to complete the manufacture, delivery and sale of the ballasttransformers.  Electronika retainsownership of all designs, drawings, specifications and intellectual propertyrights associated with the ballast transformers.  Magnetika is a manufacturing company that, inaddition to the aforementioned ballast transformers, manufactures various otherproducts similar to those of Torotel for other unrelated customers.  Magnetika’s annual sales are estimated to beabout 30% higher than the annual sales of Torotel.  Total purchases of goods from Magnetika byElectronika amounted to $5,000 for the nine months ended January 31, 2010.

 

*Business Outlook*

 

Notwithstanding the current economic climate,including the ongoing delays in aircraft orders and production, and the uncertaintysurrounding the next U.S. defense budget, the overall business outlook remainsfavorable due to higher demand for the potted coil assembly for the Hellfire IImissile system, the award of a major long-term commercial contract in February 2010valued at $1.1 million with deliveries scheduled through July 2011, andimproved quoting activity for various magnetic components.  Additionally, management believes a newlong-term contract valued at over $5.0 million for the potted coil assemblywill be awarded later in calendar 2010.

 

As of January 31, 2010, the consolidated orderbacklog was $7.0 million.  This amountwas comprised of $5.2 million for the potted coil assembly, $1.3 million inmagnetic components and $0.5 million in electro-mechanical assemblies.  New order bookings during the first ninemonths of fiscal 2010, exclusive of the potted coil assembly, decreased 12% to$3.3 million.  The industry mix ofTorotel Products’ net sales for the first nine months in fiscal 2010 was 58%defense, 26% aerospace and 16% industrial compared to 44% defense, 33%aerospace and 23% industrial for the same period last year.  This shift toward defense follows the trendexpected for fiscal 2010 because of the higher demand for the potted coilassembly.

 

The primary factors that drive gross profit and netearnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programsand complex transformer devices tend to be higher than those that are still inthe prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting periodthe mix of product shipments between higher and lower margin jobs has asignificant impact on the gross profit and net earnings of TorotelProducts.  Torotel’s operating plancontinues to focus on expanding the product base beyond electronic components.

 

Electronika’s net sales continue to be impacted by thedecline in the number of active DC-8 and DC-9 aircraft.  Management expects these sales to continue todecline and eventually phase out.

 

*Resultsof Operations*

 

The following managementcomments regarding Torotel’s results of operations and outlook should be readin conjunction with the Consolidated Condensed Financial Statements includedpursuant to Item 1 of this Quarterly Report.

 

The discussion and analysis of the results ofoperations include the operations of Torotel, Inc. and its subsidiaries,Torotel Products, Inc., Torotel Manufacturing, Inc., and Electronika, Inc.  While each company’s results are included inthe following discussion, segment reporting is not applicable because theproducts offered are similar in form and function, and target similar markets.

 

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**NineMonths Ended January 31, 2010 Compared With Nine Months Ended January 31,2009**

 

Consolidated net sales decreased 13%.  The net sales of Torotel Products decreased 11% from $5,455,000 to $4,831,000.  This decrease was attributable to the lower demand for magnetic components, molded coils and lower shipments of various assemblies.  This lower sales volume was offset partially by the higher demand for the potted coil assembly.  The net sales of Electronika decreased 89% from $124,000 to $13,000, which is consistent with the sales volume expected from Electronika.

 

Consolidated gross profit as a percentage of net salesdecreased 2%.  The gross profitpercentage of Torotel Products decreased 2% because of higher material costs associated with the product mix and lower sales volume without a comparable changein production overhead costs. Electronika’s gross profit as a percentage of net sales remainedunchanged.

 

Engineering expenses, applicable only to Torotel Products, decreased 9%from $264,000 to $241,000   because of a $20,000 decrease in payrollcosts mainly due to fewer engineering college interns employed during thecurrent period and a $14,000 decrease in training costs.  These decreases were offset partially by a$6,000 increase in travel costs, $4,000 increase in software expense, and a$1,000 increase in outside personnel. Management does not anticipate any significant increase in the presentlevel of engineering expenses.

 

Consolidatedselling, general and administrative (“SG&A”) expenses increased 18%.  The SG&A expenses of Torotel increased48% from $200,000 to $295,000 primarily because of a $31,000 change in the fair value of stock appreciation rights,a $28,000 increase in professional fees, a $16,000 increase in auditing fees, a $9,000 increase inconsulting fees, a $6,000 increase in directors fees, a $5,000 increase in annual meeting costs.  The SG&A expenses of Torotel Productsincreased nearly 14% from $1,165,000 to $1,322,000 primarily because of a $107,000 increase in recruitingcosts, a $78,000 increase in payroll-related costs, a $10,000 increase inbuilding repair costs, a $9,000 increase in stock compensation costs, a $9,000increase in information technology costs, a $5,000 increase in bank charges andrefinancing fees, and a $5,000 increase in office supplies.  These increases were offset partially by a$34,000 decrease in sales commissions, a $16,000 decrease in consulting costsand a $15,000 decrease in professional fees. Electronika did not incur any SG&A expenses in either period.  Management does not anticipate anysignificant increase in the present level of SG&A expenses.

 

Interest expense, entirely attributable to Torotel Products, decreasednearly 23% because of a lower debtlevel and a lower effective borrowing rate as a result of a refinancing of themortgage debt (see Note 5 of Notes to Consolidated Condensed FinancialStatements).

 

For the reasonsdiscussed above, the consolidated pretax earnings decreased from a profit of$351,000 to a loss of $250,000.  Thepretax loss of Torotel increased from $200,000 to $294,000.  The pretax earnings of Torotel Productsdecreased from $477,000 to $36,000.  Thepretax earnings of Electronika decreased from $74,000 to $8,000.

 

**ThreeMonths Ended January 31, 2010 Compared With Three Months Ended January 31,2009**

 

Consolidated net sales decreased 4%. The net sales of Torotel Products decreased 3% from $1,597,000 to$1,542,000.  This decrease wasattributable to the lower demand for magnetic components and molded coils.  This lower sales volume was offset partiallyby the higher demand for the potted coil assembly.  The net sales of Electronika decreased 64%from $22,000 to $8,000, which is consistent with the sales volume expected fromElectronika.

 

Consolidated gross profit as a percentage of net sales decreased 5%.  The gross profit percentage of TorotelProducts decreased 4% primarily because of the effect of higher labor costsassociated with underutilized labor resources resulting from the hiring andtraining of additional production labor in

 

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anticipationof receiving the major commercial contract discussed above under “BusinessOutlook”.  Electronika’s gross profit asa percentage of net sales remained unchanged.

 

Engineering expenses, applicable only toTorotel Products, decreased 18% from $87,000 to $71,000.   Management does not anticipate anysignificant increase in the present level of engineering expenses.

 

Consolidated selling, general and administrative (SG&A) expensesincreased 41%.  The SG&A expenses ofTorotel increased 380% from $10,000 to $48,000 primarily because of a $26,000 change in the fair value of stock appreciation rightsand a $12,000 increase in auditing fees. These increases were offsetpartially by a $2,000 decrease in liability insurance costs and a $1,000decrease in directors fees.  The SG&Aexpenses of Torotel Products increased nearly 32% from $362,000 to $478,000primarily because of a $70,000 increase in recruiting costs, a $26,000 increasein payroll costs, a $25,000 increase in training costs, an $8,000 increase inbuilding maintenance costs, and a $6,000 increase in stock compensationcosts.  These increases were offsetpartially by a $10,000 decrease in sales commissions, a $6,000 decrease inconsulting costs, and a $4,000 decrease in property taxes.  Electronika did not incur any SG&Aexpenses in either period.  Managementdoes not anticipate any significant increase in the present level of SG&Aexpenses.

 

Interest expense,entirely attributable to Torotel Products, decreased 29% because of a lower debt level and a lower effective borrowing rate as aresult of a refinancing of the mortgage debt (see Note 5 of Notes toConsolidated Condensed Financial Statements).

 

For the reasons discussed above, the consolidated pretax earningsdecreased from $102,000 to a loss of $126,000. The pretax loss of Torotel increased from $10,000 to $48,000.  The pretax earnings of Torotel Productsdecreased from $99,000 to a loss of $83,000. The pretax earnings of Electronika decreased from $13,000 to $5,000.

 

**Liquidityand Capital Resources**

 

As of January 31,2010, Torotel had $599,000 in cash compared to $656,000 as of April 30,2009 and $318,000 as of January 31, 2009. Management anticipates cash flow from operations to improve during thenext few quarters given the anticipated higher revenues from the potted coilassembly and the major commercial contract signed in February 2010.

 

The table below presentsthe summary of cash flow for the nine month periods indicated through January 31.

 
| ** **                                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash provided by  (used in) operating activities |       | $        | 60,000     |     | $          | (18,000 | ) |
| Net cash used in  investing activities               |       | $        | (74,000    | )        | $          | (21,000 | ) |
| Net cash used in  financing activities               |       | $        | (43,000    | )        | $          | (53,000 | ) |

 

Net cash provided byoperating activities fluctuates between periods primarily as a result ofdifferences in operating earnings, the timing of shipments and the collectionof accounts receivable, changes in inventory, level of sales and payment ofaccounts payable.  The $74,000 of cashused in investing activities in fiscal 2010 was the result of capitalexpenditures.  Management anticipatesapproximately $10,000 of capital expenditures during the remainder of fiscal2010.  The $43,000 of cash used infinancing activities in fiscal 2010 is the net effect of long-term debtpayments and capital lease obligations with the Bank of Blue Valley lessproceeds from a new equipment loan. Management believes that the projected cash flow from operations,combined with its existing cash balances, will be sufficient to meet itsfunding requirements for the foreseeable future.  Torotel does have a $500,000 bank line ofcredit available, which management anticipates could be utilized to help fundany working capital requirements.

 

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Management believes thatinflation will have only a minimal effect on future operations since sucheffects will be offset by sales price increases, which are not expected to havea significant effect upon demand*.*

 

Return on CapitalEmployed (“ROCE”) is the primary benchmark used by management to evaluateTorotel’s performance.  ROCE measures howeffectively and efficiently assets are used (NOA) to generate income(EBIT).  For these purposes, NOA, orCapital Employed, is defined as “accounts receivable + inventory + net fixedassets + miscellaneous operating assets — accounts payable — miscellaneousoperating liabilities”.  The performanceof Torotel’s management and the majority of its decisions will be measured bywhether Torotel’s ROCE improves.  For thefiscal years ended April 30, 2007, 2008 and 2009, Torotel’s ROCE was-7.55%, 12.25% and 18.19%, respectively. The ROCE for the 12-month trailing period ended January 31, 2010was -13.94%.  This decline in ROCE islargely attributed to the year to date operating loss.  Management believes that the ROCE value willimprove over the next few quarters.

 

**Critical Accounting Policies**

 

*Use of Estimates*

 

The preparation of theconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect certain reported amounts anddisclosures.  Significant estimates usedin preparing these consolidated financial statements include those assumed incomputing the carrying value of equipment, allowance for doubtful accountsreceivable, the valuation allowance on deferred tax assets and the reserve forwarranty costs.  Accordingly, actualresults could differ from those estimates. Any changes in estimates arerecorded in the period in which they become known.

 

*Credit Risk*

 

Financial instruments that potentially subject Torotelto concentrations of credit risk consist principally of cash and accountsreceivable.  Torotel grants unsecuredcredit to most of its customers. Management does not believe that it is exposed to any extraordinary creditrisk as a result of this policy.  Atvarious times, and at January 31, 2010, cash balances exceeded federallyinsured limits.  Torotel has notexperienced any losses in the cash accounts and management does not believeTorotel is exposed to any significant credit risk with respect to its cash.

 

*Fair Value of Financial Instruments*

 

Effective May 1,2009, Torotel determines fair value by utilizing a fair value hierarchy thatprioritizes observable and unobservable inputs used to measure fair value intothree levels as follows:

 

·                  Level 1.  Inputs to the valuation methodology arequoted prices (unadjusted) for identical assets or liabilities in activemarkets.

 

·                  Level 2. Inputs to the valuation methodology includequoted prices for similar assets and liabilities in active markets, and inputsthat are observable for the asset or liability, either directly or indirectly,for substantially the full term of the financial instrument.

 

·                  Level 3.  Inputs to the valuation methodology areunobservable and significant to the fair value measurement.

 

The fair value hierarchygives the highest priority to Level 1 inputs and the lowest priority to Level 3inputs.  In determining fair value,Torotel utilizes valuation techniques that maximize the use of observable

 

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inputs and minimize the use of unobservable inputs tothe extent possible as well as consider counterparty credit risk in theassessment of fair value.

 

The carrying amounts ofcertain financial instruments, including cash, trade receivables, prepaidexpenses and other current assets, trade accounts payable and accruedliabilities approximate fair value due to their short maturities.  As of January 31, 2010, the amount ofTorotel’s long-term debt approximates fair value based on the present value ofestimated future cash flows using a discount rate commensurate with a borrowingrate available to Torotel.

 

*Treasury Stock*

 

Torotel utilizes theweighted average cost method in accounting for its treasury stock transactions.

 

*Revenue Recognition*

 

Revenue is recognizedwhen a fixed price contract or purchase order exists; delivery has occurred;and collection is reasonably assured. Selling terms are FOB Shipping Point so Torotel considers its productsdelivered once they have been shipped and title and risk of loss have beentransferred.  Torotel’s consolidated netsales arising from contracts having deliveries scheduled over a period of morethan one year for the nine month periods ended January 31, 2010 and 2009,were approximately 34% and 20%, respectively, because of the contracts for thepotted coil assembly.

 

*Allowance for Doubtful Accounts*

 

Gross trade accountsreceivable are offset with an allowance for doubtful accounts.  The allowance for doubtful accounts ismanagement’s best estimate of the amount of probable credit losses in Torotel’sexisting accounts receivable.  Managementreviews the allowance for doubtful accounts on a regular basis, and all pastdue balances are reviewed individually for collectability.  Account balances are charged against the allowancewhen placed for collection.  Recoveriesof receivables previously written off are recorded when received.  The majority of the customer accounts areconsidered past due after the invoice becomes older than the customer’s creditterms.  Interest is not charged on pastdue accounts.  The allowance for doubtfulaccounts as of January 31, 2010 and April 30, 2009, was $6,000.

 

*Inventories*

 

Inventories are stated atthe lower of cost or market.  Cost isdetermined using a moving average cost method of valuation that currently andhistorically approximates the first-in, first-out method.  Torotel’s industry is characterized byshort-term customer commitments and changes in demand, as well as other marketconsiderations.  Provisions for obsoleteand excess inventory are based on reviews of inventory usage, quantities onhand and latest product demand information from customers.  Inventories are reviewed in detail utilizinga 12-month time horizon.  Individual partnumbers that have not had any usage or purchases  in a 12-month time period and do not have anyknown usage requirements are categorized as obsolete; individual part numbershaving more than a 12-month supply based on the current year’s usage arecategorized as excess.  Once specificinventory has been identified as excess or obsolete, the cost of the identifiedinventory is fully reserved and the cost of the inventory is not recovereduntil it is sold.  The reserve balance isanalyzed for adequacy as part of the inventory review each quarter.

 

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*Property, Plant and Equipment*

 

Property, plant andequipment are carried at cost. Depreciation and amortization are provided in amounts sufficient torelate the costs of depreciable assets to operations primarily using thestraight-line method over estimated useful lives of three to five years forequipment and ten to twenty years for buildings and improvements.

 

*Cash Flows*

 

For purposes of thestatements of cash flows, Torotel considers all short-term investmentspurchased with original maturity dates of three months or less to be cashequivalents.

 

*Warranty Costs*

 

Torotel maintains areserve for estimated warranty costs associated with products returned fromcustomers.  A limited warranty isprovided for a period of one year which requires Torotel to repair or replacedefective products at no cost to the customer. The warranty reserve is based on historical experience and reflectsmanagement’s best estimate of probable liability under the product warranties.

 

*Stock-based Compensation*

 

Torotel follows the fairvalue recognition provisions in accounting for transactions involving stockappreciation rights and restricted stock.

 

*New Accounting Pronouncements*

 

In the third quarter offiscal 2010, Torotel adopted FASB Accounting Standards Update (ASU) No. 2010-09,Amendments to Certain Recognition and Disclosure Requirements, which amends ASC855, Subsequent Events.  This ASU removesthe requirement for a SEC filer to disclose a date through which subsequentevents have been evaluated.  This changeremoves potential conflicts with SEC requirements.  The adoption did not have a material effecton Torotel’s consolidated financial statements.

 

Torotel adopted *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples*effective August 1, 2009 (see Note 12 of Notes toConsolidated Condensed Financial Statements). The FASB Accounting Standards Codification (“Codification”) isidentified as the source of authoritative U.S. GAAP recognized by the FASB tobe applied by non-governmental entities. Rules and interpretive releases of the SEC under authority offederal securities laws are also sources of authoritative GAAP for SECregistrants.  On the effective date, theCodification superseded all then-existing non-SEC accounting and reportingstandards.  All other non-grandfatherednon-SEC accounting literature not included in the Codification isnon-authoritative.

 

**Forward-LookingInformation**

 

*This report, as well as our otherreports filed with the Securities and Exchange Commission (“SEC”), and in pressreleases and other public communications throughout the year, contains forwardlooking statements made pursuant to the safe harbor provisions of The PrivateSecurities Litigation Reform Act of 1995. The words “believe,” “estimate,” “anticipate,” “project,” “intend,” “expect,”“plan,” “outlook,” “forecast,” “may,” “will,” “should,” “continue,” “predict”and similar expressions are intended to identify forward lookingstatements.  This report containsforward-looking statements regarding, among other topics, our expectedfinancial position, results of operations, cash flows, strategy, budgets andmanagement’s plans and objectives. Accordingly, these forward-looking statements are based on assumptionsabout a number of important factors. While we believe that our assumptions about such factors are reasonable,such*

 

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*factorsinvolve risks and uncertainties that could cause actual results to be differentfrom what appear here.These risk factors include: general economic conditionsin the United States and specifically, economic conditions affecting thedefense and aerospace industries, the ability to adequately pass through to customersunanticipated future increases in raw material costs, decreased demand forproducts, delays in developing new products, expected orders that do not occur,loss of key customers, the impact of competition and price erosion as well assupply and manufacturing constraints, the availability of credit, and otherrisks and uncertainties.  In light ofthese risks and uncertainties, there can be no assurance that theforward-looking information contained in this report will prove accurate, andour actual results may differ materially from these forward-lookingstatements.  We assume no obligation toupdate any forward-looking statements made herein.*

 

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**Item 4T.    Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

Torotel’s management,with the participation of the Chief Executive Officer and Chief FinancialOfficer, has evaluated the effectiveness of Torotel’s disclosure controls andprocedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of theend of the period covered by this report. Based on such evaluation, these officers have concluded that Torotel’sdisclosure controls and procedures are effective.

 

*Changesin Internal Controls*

 

There were no significantchanges in Torotel’s internal controls over financial reporting or in otherfactors that in management’s estimates have materially affected, or arereasonably likely to materially affect, Torotel’s internal controls overfinancial reporting subsequent to the date of the evaluation.

 

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**PART II.   OTHER INFORMATION**

 

**Item6.   Exhibits**

 

a)                                                        Exhibits

 
| Exhibit 31.1 |   | Officer Certification                                                                                                              |
|-------------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.2 |   | Officer Certification                                                                                                              |
| Exhibit 32.1 |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
| Exhibit 32.2 |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
| ** **           | ** ** | **Torotel, Inc.**          |
|----------------------|------------|---------------------------------|
| ** **           | ** ** | **(Registrant)**                |
|                 |       |                            |
|                 |       |                            |
| March 16,  2010 |       | /s/ Dale H.  Sizemore, Jr. |
| Date                 |       | Dale H.  Sizemore, Jr.     |
|                 |       | Chief Executive Officer         |
|                 |       |                            |
| March 16,  2010 |       | /s/ H. James Serrone            |
| Date                 |       | H. James Serrone.               |
|                 |       | Chief Financial Officer         |

 

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